For investors the world over, the last week has been anxiety inducing. Gripped by a cocktail of fear-inducing biological responses comprehended by few.
First, a contextual digression.
The week before last saw $25 billion in new cash flow into stock funds. The sixth-largest amount on record. Largely a consequence of Main Street investors finally pouring back into equities after sitting on the sidelines for most of this historic nine-year bull.
The number of individual investors claiming to be “bullish” jumped to 60 percent. The highest reading in over seven years, according to the American Association of Individual Investors.
Subsequently, Mr. Market did what he did best. After finishing January up a hefty 5.73 percent, and having finally convinced Main Street to rejoin the long-ignored equity party, he pirouetted and dropped 6.5 percent. Playing right into the confirmation bias of all those investors who’d avoided stocks since they were burned in 2008.
50,000 years of homo sapiens evolution dictates that we are loath to miss out on a party. What, with Wall Street analysts having boosted earnings forecasts to the fastest pace in 10 years? With the heady bitcoin gains having been parred and people looking to reallocate elsewhere? With economic growth finally ready to kick into a long-awaited higher gear?
Alas, even the stragglers are arriving at the party. 11:40 pm. Kegs running low. And here they come. Sheepishly knocking on the door. Looking for a good time.
Human psychology dictates that the intense desire to participate in rare and lifechanging events eventually outweighs the fear that prevented us from doing so in the first place.
We are a fearful lot. Clinging to fear like a two-year old does a blanket. But that fear is justified. Having kept us alive for millions of years. Fear, over the millennia, has become ingrained within our psyches. Imprinted on our minds. Aligned with our hormonal secretions. That survival instinct was primarily responsible for the development of the amygdala, which regulates fear like a thermostat does the temperature. It is linked to the parts of the brain that govern our senses, muscles and hormones. Enabling us to react quickly to the sight, smell or sound of any threat.
1.8 million years ago in what is today East Africa, the formerly frozen tundra to the north began to thaw. Bringing early man (hominins) to peruse his East African environs and ask, “What’s keeping us here?”
The resultant migration lasted 1.3 million years. And brought homo erectus to traverse the plains of Northern Africa and eventually arrive in Europe. Throughout that journey, fear kept him alive. As his developing brain had been programmed to fear snakes, poisonous spiders, and the myriad of apex predators roaming the African plains.
The same survival instincts that kept Neanderthal and Australopithecus alive still govern our fight or flight responses today. Only, these biological heuristics designed to prevent us from getting mauled, eaten, bit, broken or stung have become ill-suited for most of threats facing us today. As most of today’s hominins inhabit societies in which they are more likely to be harmed by automobiles, guns, disease, heartbreak or financial decline.
Yet, you don’t see people cringing and running from fast cars, hospitals or Valentine’s Day. In fact, you’re more likely to know people harboring irrational fears of snakes and spiders than of guns, cars and the flu.
A million years of programming do not come undone overnight. Regardless of how irrational.
Studies of Inuit children in Northern Canada and Alaska reveal an intense fear of snakes at the earliest ages. Especially striking when one considers that the Inuit habituate areas that are entirely snake free. Most Inuit adults have never seen a snake. Most Inuit children have no familiarity with the word “snake.” Yet Inuit children, when shown images of snakes, experience rapid heart rates, hastened breath patterns and sweaty brows.
In other words, Inuit children have no idea what they’re looking at. Yet their fight or flight mechanisms kick in. Because for millions of years, poisonous snakes and spiders, as well as big, apex predators were the biggest threat to individual existence. The fear of such creatures was imprinted within our psyches. Serving to keep us alive. So we could procreate. Ensure the propagation of our progeny. And the continuing existence of the species.
Today, we are more threatened by drunk drivers, cigarettes and obesity than snakes and spiders. Yet we don’t break into a sweat when we see a fast car, Joe Camel or a bag of donuts. As the evolutionary process has yet to imprint such survival mechanisms on our brains.
The human neural network will account for extremely negative and unpleasant events by imprinting evidence of the event’s alleged catalysts on the neo cortex. Causing people to negatively respond to stimuli that dredges up memories of such events. An affliction we refer to as “post-traumatic stress disorder.” Which manifests itself as a type of neurosis. Meant to prevent us from committing the same life-threatening errors again and again. Long before such fears are upgraded into our human software. Becoming an embedded feature within the nervous system. Like spiders and snakes once were.
These days, many of those fears are hardly life threatening. But the neuro-physiological system does not know that. Which is why the investor who lost 44 percent of his net worth in 2008 has failed to reenter the market despite the outsized gains these last nine years. Which is why that same investor, having only recently regained the courage to invest his capital into equities, broke into a cold sweat when he saw the news that the market had dropped 6.5 percent in three days.
And still, return to equity markets they do. Long after they should have. Oblivious to this long-in-the-tooth market’s fragile risk-to-reward ratio. Unconcerned that the S&P 500’s nine-year average return is north of 14 percent. Well above the long-term average of nine. And completely ignorant to the probability and impact of mean reversion.
Humans may be driven by fear. Dependent upon it, you might say. But still, we will return. Time and again. To the market. To the adrenaline rush. To the jilted lover. To the scene of the crime from whence we once ran, manically, so that we could live to fight another day.
Because the only emotion powerful enough to posit itself as a counterbalance to fear is greed. And after watching stocks go parabolic, having risen for nearly nine straight years, the gravitational pull of potential stock-market riches becomes too great. Even for those still recovering from the trauma of 2008. But return, they do. Having learned nothing. Armed with no new tools. No new resources. No new advisor. No additional training. Just the distinctly thrilling taste of greed and optimism.
Contemplating a nine-year old market. As virtually the same investor he was in 2009. When he cursed at his losses. At his financial uncertainty. At the failure of his advisor. At the lack of responses. At the consequences of his mistakes.
Just another old dog with no new tricks.